A nervous “three speed” recovery

Fri, 2013-07-19 09:58

An interesting description of the global economic situation came out of the press conference heralding the most recent World Economic Outlookcrafted by the International Monetary Fund(IMF) last week: a global economy stick in “three speed mode,” in the words of Olivier Blanchard, economic counselor and chief economist for the IMF, with emerging markets still growing rapidly, the U.S. economy experiencing a steady yet sluggish recovery, while Europe continues to struggle.

“There is, however, a twist to that story, which is that growth almost everywhere is a bit weaker than we forecast last April, and the downward revisions are particularly noticeable in emerging market countries,” he added. “After years of strong growth, the emerging market economies—the BRIC [Brazil-Russia-India-China] markets, to call them that way, are beginning to run into speed bumps. This means that the focus of policies will increasingly need to turn to boosting potential output growth or, in the case of China, to achieving more sustainable and balanced growth.”

[You can watch Blanchard discuss those and other trends in the video clip below.]

Overall, the IMF expects global economic growth to remain subdued at slightly above 3% in 2013, the same as in 2012. Where the U.S., the IMF is now forecasting growth of 1.7% this year: a downward revision of 0.2%, but with expectations for a rebound to occur in 2014, when the IMF believes growth will hit 2.7% in the U.S.

In some ways, that “three speed” view of the global economy is an apt description of the competing perspectives on domestic economic growth: some are very bullish concerning prospects for U.S. growth, others see things staying the same, while still others think there’s a lot of trouble in store for our nation. [A good example of the gloomy take on things can be found in this opinion column here.]

The IMF’s Blanchard, for one, thinks the U.S. is on a good glide path. “The slowdown in the U.S., this 0.2% revision, is not particularly worrisome,” he said. “What it hides is a robust recovery in private demand. What has happened is that that stronger than expected, and stronger than desirable, fiscal consolidation has been only partly offset by good performance of the housing market, with the net result being a small downward revision. If fiscal consolidation had been weaker, then growth in the U.S. would be substantially higher.”

In addition, 72% of respondents believed the U.S. economy grew in the second quarter, up 10 points from the prior quarter, though it’s worthy to note that sentiment pertaining to the world economy remains guarded with only 31% expressing optimism and 59% voicing continued uncertainty, noted Bobby Bono, U.S. industrial manufacturing leader for PwC.

"There remains a persistent dichotomy in viewpoints regarding the outlooks for the U.S. and world economies,” he added. “Optimism regarding the domestic economy has increased, while worldwide economic sentiment remains restrained, with global uncertainty reaching the highest level in the past 12 months.”

Still, Bono pointed out that the “U.S. is starting to show signs of healthy demand trends and improving pricing power, supporting positive overall sentiment in the year ahead,” though as a result of the mixed global outlook, combined with the moderate domestic recovery and the specter of increased legislative and regulatory pressures, management teams are continuing to carefully manage their costs, while maintaining a focus on growing profitably.

Another survey indicates strong optimism for the U.S. and the world, if you can believe it.

The Global Confidence Index – developed in conjunction with Roy Black, director of the real estate program at Emory University's Goizueta Business School in Atlanta – polled 90 executives at major multi-national corporations spread across a wide range of industries and found that their outlook is strong for the second half of 2013, while the prospects for corporate growth and expansion are also increasing.

According to the predictive survey, nearly two-thirds (62.5%) rated their outlook on the global economy for the coming six months as optimistic to very optimistic, compared to a year ago. Almost one-third (31.3%) were neutral on the question, with only incremental pessimism registered (4.2%).

Executives in the CoreNet Global survey also ascribed even higher confidence levels to the likelihood of their companies' growth for the second half of 2013, with a strong majority rating their confidence levels in the prospects for business expansion as optimistic (54.2%), very optimistic (14.6%), and extremely optimistic (4.2%).

Indeed, PwC found similar levels of optimism regarding revenues in its survey, where 82% of the industrial manufacturers polled expecedt positive revenue growth for their own companies in the next 12 months, with only 3% forecasting negative growth.

The projected average revenue growth rate over the next 12 months is expected to be 4.6%, up from 4.3% in the first quarter, but down from 5.6% in last year's second quarter.

Despite the reduced rate of forecasted growth, PwC’s Bono said the outlook for the U.S. continues to contrast with the international picture, where optimism regarding commerce in the next 12 months was only 31%, compared to 36% in the first quarter. In addition, the projected contribution of international sales to total revenue over the next 12 months remained low at 32%, consistent with the first quarter survey, but down from 37% in the second quarter of last year.

In some ways that “dichotomy” isn’t surprising, since perspectives based on economic data, though, are leading many to think the U.S. economic engine may be shifting to neutral.

Take the Conference Board’s most recent Leading Economic Index (LEI) for theU.S., for example: it remained unchanged in June, at 95.3, which followed a 0.2% increase in May and a 0.8% increase in April.

"The U.S. LEI was flat in June [as] declines in building permits, new orders and stock prices were offset by gains in consumer expectations, initial claims for unemployment insurance, and other financial indicators," noted Ataman Ozyildirim, one of the chief economists for the Conference Board. "However, the LEI's six-month growth rate remains positive, suggesting the economy will continue expanding through the end of the year."

"Some segments of the economy are turning around faster than others, resulting in positive but moderate growth," added Ken Goldstein, another Conference Board economist. "The biggest uncertainties remain the pace of business spending, the improvements in consumer spending power and the impact of slower global growth on U.S. exports."

PwC’s Bono echoed that sentiment based on his firm’s survey findings.

"Sustained global uncertainty has likely led the way in fostering a more measured approach to capital spending, in conjunction with a return to more normalized spending patterns commensurate with the current stage of the post-recession cycle," he explained. "We are also continuing to see little enthusiasm for overseas expansion, while management teams target spending primarily on R&D, new product launches and IT [information technology]. This suggests they are focusing inward on innovation and leveraging their core strengths in a competitive domestic environment."

So, where do we go from here? Well the IMF’s Blanchard believes that all the nations participating in the global economy – whatever their “speeds” – must keep a close watch on several risk factors; some old and some very new.

"The old risks are still very much present, the main one being the state of Europe and things which can go wrong there," he said. “Here’s what we see as three main new risks."

The first is risk to growth in China. "After a very large increase in investments since the beginning of the crisis, an increase which was largely financed through the shadow banking system, Chinese policymakers face a difficult choice: either letting investment remain high at the risk of increasingly unproductive investment at the margin, and the buildup of credit risks; or tightening credit, slowing investment and risking a decrease in growth because consumption is unlikely to increase fast enough to compensate for the decreasing investment," Blanchard said. "As a result, this is a difficult path to negotiate, and we see potential downside risks to growth in China."

The second risk is Japan's “Abenomics,” a three-pronged “arrow” policy named after that nation’s prime minister that iscentered on fiscal stimulus, aggressive monetary easing, and structural reforms.

“On this, unless the second arrow, which is the fiscal stimulus, is soon complemented by credible medium-run fiscal plan, and the third arrow, which is the structural reforms, reflects substantial reforms, I think the risk is that investors will become worried about that sustainability and then ask for higher interest rate on Japanese government bonds,” Blanchard said. “And this clearly would make it difficult for Japan to maintain that sustainability and put Abenomics in trouble.”

The third risk is the one associated with exit from quantitative easing in the U.S.

“We attribute the high volatility of financial markets in the recent past, not so much to news from the Fed, but to the sudden realization by investors that quantitative easing would eventually come to an end,” Blanchard warned. “As they tried simultaneously to rebalance their portfolios both in the U.S. and abroad, the result was some overshooting, isolated dislocations in some markets, and high volatility. Going forward, we expect volatility to decrease, maybe not back to the levels of a few months ago, but to decrease relative to the highs of the recent past, but one cannot rule further attacks of nerves along the way.”

And an “attack of nerves” is something we really don’t want to see, especially in terms of how it might impact freight volumes.